Diamond Resorts International Inc (DRII) And Its Perpetual Mortgage Machine by Roddy Boyd, SIRF

Since 2007 the website of Diamond Resorts International has made people think their personal six-night stay in heaven is only a few clicks away.

Online the company’s resorts, full of beaches and golf courses, still beckon. But Diamond is a 21st-century time-share operation and investors ought to be wary of any company using the controversial vacation concept that has provided decades of fodder for comedy writers while troubling state and federal regulators.

Indeed what Las Vegas-based Diamond is selling is a sleeker, more expensive iteration called a vacation-ownership interest or VOI. And it seems to have proved successful for Diamond, at least thus far.

As is the case with buying a time-share, customers purchase from Diamond Resorts the right to an annual one-week vacation at a resort. There are some important differences, though: Customers aren’t receiving a deeded right to a week’s stay at a specific resort. Rather, they gain the right to stay at a collection of company-owned properties in the United States, South America, Europe or Asia.

[drizzle]They can also buy a membership in a “trust” that allows for stays at other venues: When buying the vacation-ownership interest, they receive “points” that can be redeemed for a week’s stay — even at resorts and on cruises with which Diamond is affiliated but doesn’t own.

The concept of points is key. Think of them as a virtual currency, albeit one for which Diamond Resorts is both the dealer and the Federal Reserve. Purchasing more points means that a member has greater latitude to book a vacation, especially during peak seasons. It also means that the customer has spent a good deal of money.

In contrast, having a lower point total may require a member to reserve certain properties as much as 13 months in advance. Determining the price of points is part of the VOI negotiation process when a new member signs up. Thus, a point does not have a fixed dollar value: A chart, with data culled from member lawsuits against Diamond, seems to indicate that over the past three years the dollar value of a point has been trending lower.

Customers can expect to pay about $26,000 for a VOI for one week a year and about $1,460 in annual maintenance fees.

And a VOI is a so-called perpetual use product with a lifetime contract that’s difficult for a member to be extricated from — and there’s no resale market that he or she could tap for cash. The mandatory five- to 10-day cooling off period after a member first signs up is the only chance a customer has for canceling the contract before entering a lasting financial commitment to Diamond. (The company has said it may make some modifications to this policy in the future.)

Diamond Resorts faces considerable challenges in selling its main product — the VOI — given the current economics of the travel industry. Travel websites and apps like Expedia.com, Hotels.com and Airbnb frequently let would-be vacationers procure the equivalent of a Diamond resort stay for less than the company’s annual VOI maintenance fees. Many Diamond resorts even allow nonmembers to reserve rooms through consumer travel sites. But when a member relies on Diamond’s financing (banks don’t do VOI financing), this can push the combined annual maintenance fee and loan-payment expense to more than $6,000, a mighty price tag for a week’s stay.

Diamond disagreed with this assessment, arguing at length that focusing solely on cost sacrifices the value of convenience and flexibility.

One fact that Diamond’s management might not dispute is the warm reception investors and brokerage analysts have bestowed thus far. Rare indeed is the brokerage analyst who has not been impressed by Diamond Resorts has sustained growth trajectory: The company booked more than $954 million in sales last year, a spike from 2012’s $391 million.

And Diamond’s share price has steadily ticked northward, from $14 during its July 2013 initial public offering to $35 a year ago. This resulted in a $2 billion market capitalization when the company’s shares reached their peak value in February 2015. For the founding management and investment group that still owns more than 35 percent of the shares outstanding, this translated into over a $600 million stake at that time.

Yet in late January, a New York Times investigation showed that some of Diamond’s rapid growth might be due to overly aggressive sales practices. The Times article roundly spooked investors and almost $300 million of market capitalization was lost for more than three weeks before Diamond’s share price recovered. In response, the company issued a press release emphasizing its “zero tolerance” policy toward misleading sales tactics.

The Southern Investigative Reporting Foundation spent two months investigating Diamond’s murky soup of public accounting and disclosures to explore the financial mechanics of the company’s success. This investigation found that the financial statements have a very large red flag.

Simply put, there are a lot of close parallels to how subprime mortgage finance companies rapidly expanded in the last decade. The most obvious similarity lies in the drive to ensure a steady stream of borrowers whose down-payment cash will keep a company operating.

Diamond faces four interconnected problems: The company cannot survive on the amount of cash sales it makes, so it needs to finance sales. Diamond has to securitize those loans to bring cash in the door or run the risk of losing money on every sale. To retain favorable terms for monetizing its debt, the company has to use its own cash to make up shortfalls in the securitization pools. Since the realized value on customers’ loans is less than the amount Diamond Resorts has borrowed against them, it needs to monetize new loans faster and faster.

Recent history suggests that the fate of a company like this is not pretty.

(In an effort to provide readers a clearer view of Diamond’s responses, the company’s replies in full to specific questions have been embedded throughout this story. Of special interest are the replies supplied on Feb. 11, Feb. 12, Feb. 16, Feb. 17 and March 4.)

Since 2011 Diamond has experienced a decline in its VOI sales to new members as a percentage of the company’s entire VOI sales (although the percentage did modestly increase last year from 2014). According to the just-filed 10-K annual report for 2015, 21 percent of last year’s VOI unit revenue came from new members. In 2011, that figure was 34 percent. What’s the reason for the broad decline? It’s not immediately clear.

Diamond dismissed a reporter’s recent question about the possibility of a decline in VOI sales to new members, citing the dollar growth of their purchases. (The estimated dollar value of new member sales did increase to about $148.1 million last year from $135 million in 2014.)

By contrast, new members at Diamond’s two biggest rivals, Marriott Vacations Worldwide and Wyndham Worldwide, accounted for 36 percent and 32 percent, respectively, of their companies’ VOI revenues last year.

Common sense would suggest that absent large blocks of new members arriving organically or through a purchase of a rival company, Diamond’s continually pushing current members to upgrade their VOIs will eventually result in diminishing returns.


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